There is mounting evidence that neither David Murray nor Treasurer Joe Hockey are going to be soft-touches on Australia’s major banks, which are now worth over $400 billion and notably more than they were prior to the global financial crisis.

Sources who have spoken to both men suggest the Financial System Inquiry’s final recommendations on the extra equity capital required to, firstly, compensate for the four majors’ “too-big-to-fail” status and, secondly, reduce the enormous “risk-weighting” differentials enabling them to carry less than half the capital of competitors when lending against housing, could surprise with their policy purity.

Both men reject the proposition tendered by the major banks that they are already better capitalised than similarly sized institutions around the world, and are inverting the “funding Australia” meme the banks have advanced to protect their internationally lofty returns on equity.

Murray and Hockey stand by analysis published in the inquiry’s interim report that says the major banks’ tier one capital is only middling by global standards and certainly not excessive. They also believe that as a capital-importing nation that runs persistent current account deficits via the majors – which rely much more on volatile wholesale bond markets than their primarily deposit-funded peers – there is a case they should be especially prudent vis-à-vis overseas institutions.

The logic is that additional capital and less leverage means the majors will be able to raise money more easily during crises and reduces the likelihood they have to draw on taxpayer guarantees. As structurally less-risky concerns, they should also pay less for their debt and equity capital.

Murray made most of his wealth during his tenure as chief executive of Commonwealth Bank between 1994 and 2005, which left him with shares and options that would be worth more than $60 million today.

Hockey, who is married to a former Deutsche Bank trader and appointed UBS’s head of fixed-income as his chief of staff, has always been “sympathetic” to financiers. His former spinner and current columnist for this newspaper, Joe Aston, told Hockey’s biographer that “around the big banks and financial services industry – they love him”.

Notoriously independent

I’ve criticised Hockey for refusing to disclose what percentage of the panel members’ net wealth is invested in major and other bank stocks, and for failing to appoint a single experienced government policymaker.

The inquiry is dominated by individuals who have made their money in banking, including the former chief executives of CBA and AMP, and a long-time Westpac director. And its advisory board includes the former chief executive of Westpac, David Morgan, who now works for a private equity firm that specialises in bank investments, the boss of one of the world’s biggest hedge funds, which presumably holds bank securities, and a current JPMorgan investment banker.

Yet sources say Murray, who had previously defended the majors’ high leverage, is notoriously independent and no bank patsy. Indeed, he is allegedly disliked by many of his banking alumni.

When I worked with Hockey in late 2010 on the policy platform for the Financial System Inquiry, and its first terms of reference, which Murray inputted into, he had me convinced he was committed to cauterizing the too-big-to-fail problem and pricing (or removing) the complex taxpayer subsidies that arguably make banking Australia’s most favoured industry.

Sources close to Hockey say he does not think reforming the banks will be a tough political battle to win given Labor and the Greens are already on side. Recognising the legacy-shaping nature of the inquiry, Hockey is said to be particularly focused on “doing the right thing”.

This includes tackling the thorny issue of “vertical integration”, whereby the big banks have been consolidating non-core sectors, including asset management, superannuation, financial planning, equities and other investment banking activities.

One interesting insight into Hockey’s thinking is his view that Australia needs to ultimately move towards decoupling product manufacturing from financial planning, which goes to the heart of the conflict of interest debate that has plagued the 70 per cent of advisers who are now owned by, or aligned to, institutions care of vertical integration.

Addressing the major banks’ too-big-to-fail subsidies and remedying the regulatory comparative advantage afforded through the lopsided risk-weighing system, which is the main driver of their superior profitability, would materially enhance competitive neutrality.

Ever since the Basel II rules were introduced in 2008 by the Australian Prudential Regulation Authority, the majors have been able to leverage their core equity capital more than twice as much as rivals (save Macquarie Bank) when lending against housing.

This allows them to produce twice the returns on equity for what are practically similar home loan assets and has coincided with a sharp break in regional and major bank profitability, which has been amplified by the higher funding costs paid by smaller institutions that are assumed not to be too-big-to-fail.

The Australian Financial Review

BY Christopher Joye

Christopher Joye is a contributing editor to The Australian Financial Review. He is a leading economist, fund manager and policy adviser who has previously worked for Goldman Sachs and the RBA, and was a director of the Menzies Research Centre. He is currently a director of Smarter Money Investments.

BY Christopher Joye

Christopher Joye is a contributing editor to The Australian Financial Review. He is a leading economist, fund manager and policy adviser who has previously worked for Goldman Sachs and the RBA, and was a director of the Menzies Research Centre. He is currently a director of Smarter Money Investments.